Some Lines In The Sand Go, But New Ones Will Drawn
By Win Thin
With BRL breaking below 1.65 and KRW below 1100, it is tempting to suggest that EM policy-makers are becoming more willing to accept currency strength to help limit inflation. We’ve heard this many times before, almost every time a major EM currency breaks a notable resistance level. But what typically follows is not ongoing appreciation, but simply a new level and new efforts to defend it. That’s what we highlighted yesterday in our Brazil piece. “Letting the 1.65 line in the sand go this week (if that is indeed the case) shouldn’t be seen as a complete change in strategy, but rather just a small shift. Remember, that line in the sand was once 2.00, then 1.75, and then 1.70 before the current 1.65.”
Given how aggressive both Brazil and Korea have been in trying to limit currency strength this past year, we stress again that we do not think they are openly embracing that strength. BOK was reportedly intervening today and buying USD for KRW, hardly a sign of acceptance. And while Brazil has not taken aggressive FX measures this week, the central bank intervened twice in the spot market and once with reverse currency swaps yesterday, and has already acted once in the spot market and with reverse currency swaps today. Again, this is not a sign of embracing BRL strength.
We stand by our call for stronger EM currencies this year, but warn investors not to expect large-scale gains like we saw in 2009 but perhaps more on the scale of 2010. A slow and steady slog is expected, with EM policy-makers continuing to try to slow the currency gains. Lines in the sand will remain, but those lines will be adjusted periodically as EM policy-makers find they cannot reverse the trend, but only slow it. Data out of Asia suggests that global investment flows are returning to EM, with India, Philippines, Korea, and Thailand posting positive inflows into equity markets in March after many EM equity markets saw outflows in January and February. This is what we expected. Once the rotation from EM back into DM was complete, both DM and EM markets could rise in tandem and that’s what we are seeing now.